German Bonds Drop as Inflation Data Fail to Stoke Fresh Buying

German government bonds fell, with 10-year yields reaching the highest in a week, amid speculation the lowest inflation rate in four years will not be enough to spur the European Central Bank to increase stimulus.

Benchmark bunds also declined as Russia and the U.S. sought a diplomatic solution to the crisis in Ukraine, reducing demand for the euro region’s safest assets. The extra yield investors demand to hold Spanish 10-year bonds instead of German bunds narrowed to the least since October 2010 as Royal Bank of Scotland Group Plc said the rally in the securities of Europe’s most-indebted nations can extend. Reports last week showed inflation in Germany and Spain slowed this month.

“The number wasn’t enough to boost bonds further, so it was a trigger for some profit taking,” said Jan von Gerich, a fixed-income strategist at Nordea Bank AB in Helsinki. “The expectations were lower because of the Spanish and Germany numbers. The risks are for a disappointment from the ECB and higher rates.”

Germany’s 10-year yield climbed two basis points, or 0.02 percentage point, to 1.57 percent at 4:17 p.m. London time after rising to 1.60 percent, the highest since March 24. The 1.75 percent bund due in February 2024 fell 0.185, or 1.85 euros per 1,000-euro ($1,379) face amount, to 101.645.

Euro-area consumer prices grew 0.5 percent in the year through March, after a 0.7 percent gain in February, the European Union’s statistics office in Luxembourg said. The median forecast in a Bloomberg News survey of economists was for a 0.6 percent increase. The inflation rate has been less than 1 percent for six months, while the ECB seeks to keep it at just below 2 percent.

German Inflation

Germany’s annual inflation rate slowed to 0.9 percent, down from 1 percent in February, data on March 28 showed. Spanish consumer prices, calculated using a European Union method, fell 0.2 percent from a year ago, the first decline since October 2009, a separate report showed.

ECB policy makers will leave the benchmark interest rate at a record-low 0.25 percent at their meeting on April 3, according to the median estimate of economists in a Bloomberg survey. Three of the 57 analysts are calling for a rate cut.

There were “hopeful signs” from a meeting between U.S. Secretary of State John Kerry and Russian Foreign Minister Sergei Lavrov in Paris yesterday, German Foreign Ministry spokesman Martin Schaefer said today.

Spreads Narrow

Spain’s 10-year yield was little changed at 3.24 percent, reducing the spread over similar-maturity bunds by two basis points to 167 basis points. The difference shrank to 165 basis points today, the least since October 2010.

The equivalent Italian spread narrowed three basis points to 173 basis points after touching 171 basis points, the lowest since June 2011.

RBS’s yield-spread target for Spanish and Italian bonds over benchmark German bunds has been lowered to 100 basis points from 150 basis points, strategists including London-based Harvinder Sian, wrote in a note dated March 28. That would be the lowest since May 2010, according to closing-price data compiled by Bloomberg.

Spanish and Italian five-year yields dropped to records last week as investors return to the markets they shunned during the region’s debt crisis.

“The number-one fixed-income trade in the world, which we hold with high conviction, remains intact -- long five- to 10-year periphery,” Andrew Roberts, head of European rates strategy at RBS in London, wrote in the note, referring to bets the prices of bonds from the euro area’s most-indebted nations will rise. “We are on a revaluation process for the periphery as the market realizes they are not actually that periphery anymore.”

Bond Returns

Spain’s bonds returned 6 percent this year through March 28, according to Bloomberg World Bond Indexes. Italian securities added 5.2 percent, and Germany’s gained 2.7 percent.

Spain plans to sell bonds with a maturity of more than 30 years and is studying the issuance of 50-year securities, Treasury Head Inigo Fernandez de Mesa said in an interview with Cinco Dias.

Volatility on German bonds was the highest in euro-area markets today, followed by those of Austria and Finland, according to measures of 10-year debt, the yield spread between two- and 10-year securities and credit-default swaps.

Before it's here, it's on the Bloomberg Terminal.